Senate Appropriations Hears SEC and CFTC

On June 24, the Senate Appropriations Committee's Financial Services and General Government Subcommittee, chaired by Tom Udall, D-NM, heard from Mary Jo White, the new chairman of the Securities and Exchange Commission (SEC), and Gary Gensler, the likely outgoing chairman of the Commodity Futures Trading Commission (CFTC), on their budget requests for fiscal year 2014 before four senators.

Udall played the role of Chairman Obvious in a lengthy, boring opening statement that rehashed the statements of the witnesses and the mission statements of the agencies, and he continued in this vein in his first round of questioning. He even mispronounced Gensler's name.

The other Democratic senator who participated, Chris Coons, D-Del., stated that he would support adequate funding for the agencies, but otherwise, his lame questions parroted the industry position, which has been critical of the agencies for taking divergent positions on the so-called "cross border" application of derivatives regulation under Title VII of Dodd-Frank. He even trotted out the tired argument that implementation of Title VII would place U.S. traders at a competitive disadvantage in global markets.

However, nearly all of the energy came from the two Republicans, Mike Johanns, R-Neb., and Jerry Moran, R-Kan., both also members of the Senate Banking Committee.

The following are the major issues and themes pursued during the questioning of the chairmen:

1. Budget. Johanns sharply challenged the witnesses to explain why they think their agencies are entitled to large increases in appropriations at a time when the government is operating under a "continuing resolution," which means that there are no increases, and the budget is further subject to sequestration, which calls for across-the-board cuts. Johanns pointed out that Congress is operating under the Budget Control Act, which will constrain it for 10 years, not just for a temporary period.

Moreover, he admonished Gensler that it is not a good idea for him to use his personal email account to conduct public business. Johanns pointedly asked Gensler to make the case for why he should win and White should lose funding. (If there is a solution to this puzzle of how to fund the most significant regulatory activities, it would begin with an study, perhaps by the Government Accountability Office, of the state of the bloated financial regulatory enterprise to see where duplication can be eliminated, especially among the banking regulators, so that funds could be reallocated to support securities and commodities regulation. Ironically, Congress has aggravated the budget pressure by creating a bunch of new agencies under Dodd-Frank itself.)

2. Cross border application of Title VII. This issue comes up at every hearing involving the CFTC and SEC, and Johanns, essentially repeating Coons' points, made an impassioned argument about the CFTC's effort to apply its derivatives regulations to transactions involving U.S. persons even if the deals are conducted in foreign jurisdictions. He complained that this has created uncertainty for the industry, upset a group of foreign finance ministers and led one of Gensler's colleagues, CFTC Commissioner Mark Wetjen, to ask for more time to gather information regarding the impact of the rules.

Here the irony is that Wetjen was appointed by Senate Majority Leader Harry Reid, D-Nev., for whom he worked in the Senate. One might have assumed that Reid appointed his own staffer in order to ensure that Gensler would have at least one reliable vote in favor of implementing Dodd-Frank, but that would be a reckless conclusion to draw. Just another twist in a diabolical plot.

Meanwhile, the SEC has proposed a more industry-friendly regulation that applies to security-based swaps and allows so-called "substituted compliance" to relieve firms of the burden of complying with U.S. regulations when the regulator in the country where the transaction takes place has an equivalent regulation in place.

Gensler tried to explain to Johanns that the CFTC has taken several steps to move closer to the SEC's position and that the CFTC does not want to impose duplicate regulation, but it is necessary to regulate transactions that are moved offshore in order to escape regulation, given the expectation that the risk will come back to this country if the U.S. parent fails. (Ironically, again, the SEC regulation calls for determinations on a case-by-case basis and requires a lot of lawyering. White's husband, a former senior staffer at the SEC, now practices at one of the leading law firms clients would consult in order to ensure they could meet the requirements for substituted compliance.)

3. JOBS Act. Ironically, the same Republican senators who are so determined to delay the implementation of most of Dodd-Frank are furious that over a year after enactment of the Jumpstart Our Business Startups (JOBS) Act, the SEC has still not promulgated its regulations. Circumstantially, it appeared that former SEC Chairman Mary Schapiro may have chosen a thorough rulemaking process in order to retaliate for their opposition to Dodd-Frank regulations.

Now that White has succeeded Schapiro, the bipartisan sponsors of the JOBS Act are eager for action, and White has promised that no regulations will have higher priority.

Moran complained that under the JOBS Act, general solicitation of securities may be made to accredited investors, but the industry has not been able to figure out how to establish the qualification of accredited investors, and unless the regulation solves this problem, there will be no sales and the potential of the Act will not be realized.

4. Protecting customer funds – or not. Udall asked Gensler what the CFTC has done to put in place protections against customers losing their funds when futures commission merchants (FCMs) invest them for their own benefit and later fail, as has happened twice in 18 months with MF Global and Peregrine Financial Group. (Customers had been under the mistaken impression that segregated funds were actually protected in some fashion from misappropriation by the FCMs, but they were wrong. The actual policy is something called LSOC, an Orwellian term that stands for "legal segregation with operational comingling.")

Gensler touted a measure that would enable the National Futures Association, which is the self-regulatory organization for the futures industry, to get direct information as to how much is in the accounts. (This is a solution for the problem of falsification of bank statements, but Gensler chose not to emphasize that it is not a solution for comingling, and the CFTC has done little since it adopted a regulation in 2011 that was admittedly not aimed at closing the LSOC loophole. In fact, the industry and its customers are ambivalent over whether even to do so, because revenue from FCM investments can defray the cost of administering the funds.)

5. Disclosure of political spending. As Udall took repeated turns at questioning the witnesses, he engaged White in an inquiry regarding the status of a project to require disclosure of political spending by corporations.

He asserted that a 100-year-old policy against corporate expenditures had ended with the Supreme Court's decision in Citizens United and that huge corporate treasuries are now in play to finance a variety of political activities, with 40 percent of companies maintaining some sort of political program.

After White repeated the statement she had made in the recent House hearing — that the Division of Corporation Finance has the matter under consideration, that she has received no recommendation from the Division of Corporation Finance, that no drafting is currently under way, that nothing will happen until the Division of Corporation Finance reports and that the Commission has its hands full with implementing Dodd-Frank and the JOBS Act — Udall persisted in trying to extract a commitment and a timetable from her, to no avail.

One question that probably should have been asked but was not is whether the troubled effort to implement derivatives regulation might be futile because the industry has decided it can achieve friendlier regulation by recasting its derivative product as futures.

I have predicted from the outset of the debate over Dodd-Frank that ultimately the legislation would not be implemented. Three years after enactment, as the agencies struggle with the "limplementation" of this legislation, the highly compensated executives, lawyers and lobbyists in the industry may be complaining, but they've got to be very pleased with their handiwork.

On June 24, the Senate Appropriations Committee's Financial Services and General Government Subcommittee heard from Mary Jo White, the new chairman of the SEC, and Gary Gensler, the likely outgoing chairman of the CFTC, on their budget requests for fiscal year 2014.